Source: Robert Moore
On July 26, 2023, Representatives Jimmy Panetta of California and Mike Kelly of Pennsylvania introduced legislation related to farm estate taxes. The proposed bill seeks to increase the limit on the deduction that can be taken by farmers under Section 2032A of the Internal Revenue Code (IRC). The 2032A provision in the IRC allows farmers to value their land at agricultural value, rather than fair market value. However, the current law limits the deduction to $1.16 million. This relatively small deduction can limit the usefulness of 2032A for some farm estates.
Consider the following example:
Farmer’s estate includes 500 acres with a fair market value of $5,000,000. The agricultural value, allowed by 2032A, is $4,500/acre or $2,250,000. The difference between the fair market value and the agricultural value is $2,725,000. So, by using 2032A valuation, the land value can be reduced by $2,725,000. However, 2032A limits the deduction to $1,160,000. Therefore, Farmer’s estate can actually use less than ½ the reduction in land value.
The newly introduced legislation would increase the 2032A deduction limit to the federal estate tax exemption, currently $12,900,000. Applying the proposed legislation to the above scenario, Farmer’s estate would be able to deduct the entire $2,725,000.
The farm value of farmland is determined by a formula included in the IRC. The value is the net cash rent of comparable land less real estate taxes divided by the Farm Credit System Bank interest rate, which is 4.57% for a 2022 Ohio estate. Let’s assume the fair market cash rent for a farm is $220/acre less $50/acre for taxes. Dividing by the interest rate, we get a value of $3,720/acre. The 2032A rate (farm value) is usually 1/3 to ½ of the fair market value.
If we use the $3,720 as the farm value and $10,000/acre for fair market value, 2032A reduces the value of the farmland by $6,280/acre. Dividing the per acre savings into the 2032A limit of $1,160,000 results in 185 acres. So, a reasonable estimate is that the 2032A limit only allows farmers to apply the 2032A special valuation to about 185 acres (assuming $220 rent and $10,000 FMV). Conversely, if the 2032A limit is increased to $12,900,000, the farm value could be used on over 2,000 acres. Increasing the 2032A exemption limit to $12,900,000 could save as much as $4,696,000 in estate taxes for some farm estate.
It is important to note that 2032A is only needed by farmers whose estate value will exceed the federal estate tax limit. For example, a farmer that died today with a net worth of $12,900,000 or less would owe no estate tax and thus would not need to take the 2032A deduction. According to the USDA, of the approximately 31,000 principal farm operators who died in 2020, only 50 (0.16%) owed estate taxes. With the current high estate tax exemption, less than 1% of farmers owe federal estate taxes and thus the 2032A limit is not an issue for the vast majority of farmers.
Unfortunately, this could change soon. In 2026, the federal estate tax exemption is scheduled to be reduced to around $7,500,000. We will not know the exact number until 2026 because of adjustment for inflation, but it will be somewhere around ½ of what it is now. Congress can extend the current, higher exemption or make it permanent, but no one seems to know the likelihood of that happening at this point. If the federal estate tax exemption does come back down in 2026, and with the increases in land prices the last few years, 2032A may become needed by many more farm estates.
Let’s take a look at how 2032A would play out in 2026. Consider the following scenario:
Farmer dies in 2026 and the federal estate tax exemption is $7,500,000. His net worth is $10,000,000 with $7,000,000 in farmland. The estate is $2,500,000 over the estate tax exemption limit which would result in $1,000,000 in estate taxes. If the 2032A exemption remains at $1,160,000, we can further reduce the estate by that amount, leaving $1,340,000 over and $536,000 of tax liability. If the newly proposed 2032A legislation is passed, the Farmer’s estate will be able to deduct at least $2,500,000 using 2032A, leaving Farmer’s estate with $0 tax liability.
As the scenarios and discussion shows, increasing the 2032A exemption limit will help farm estates, especially if the estate tax exemption is reduced in 2026. The proposed legislation has been introduced in the prior two Congresses and both times did not make it out of the House Ways and Means Committee. We will keep you updated on the status of this legislation and if it begins to make its way through Congress.